RBI monetary policy: 5 things to watch out for today

Of the 15 economists surveyed by Mint, 11 expect the RBI to cut the repo rate—the rate at which the central bank infuses liquidity in the banking system (or lends to banks)—by 25 basis points. Photo: Aniruddha Chowdhury/Mint

Mumbai: The Reserve Bank of India’s monetary policy committee (MPC) is scheduled to announce its policy decision at 2.30pm on Wednesday. Given the record fall in retail inflation, a rate cut is likely on the cards.

Of the 15 economists surveyed by Mint, 11 expect the central bank to cut the repo rate—the rate at which the central bank infuses liquidity in the banking system (or lends to banks)—by 25 basis points. One basis point is a hundredth of a percentage point.

Beyond the rate action, here are five things to watch out for the policy:

Language

Markets carefully weigh each and every word spoken by central bankers. Hence, language is sacrosanct in their communications. At the present juncture, with consumer price index-based inflation at 1.54%, and sagging private investment, the calls for monetary easing have strengthened. At the same time, some economists argue that there is case to adopt a wait-and-watch mode given the upside risks to inflation. Whatever may be the MPC’s decision, it will have to do a lot more convincing without flip-flopping on earlier guidance.

In case of rate cut, RBI governor Urjit Patel may find it tougher to explain the rationale for various reasons. Firstly, a rate cut could ease borrowing cost and spurs investment. However, investment and credit demand is sluggish because of reasons other interest rate. Secondly, banks have not yet fully transmitted previous rate cuts into loan rates. Thirdly, so far, only one inflation print has fallen below 2%, the lower bound of the target range the MPC is mandated with. Monetary policy decisions are based on the expected inflation trajectory. Hence, justifying a rate cut again looks difficult.

On the other hand, in case the MPC opts for status-quo, it can’t mince words while explaining the rationale. At best, it may back up this decision with the usual reason of awaiting further data. But for an inflation targeting central bank, this reason looks tough especially when CPI has been consistently undershooting its own forecast. Core inflation, which excludes volatile components of food and fuel, has also been falling, and growth remains sluggish. While these factors calls for a rate cut, a decision otherwise again looks difficult to explain.

To use the bird analogy, it remains to be seen if the RBI chooses to be a vigilant owl rather than a hawk or a dove.

Dissent

June was the first policy which saw a dissent vote, since the MPC started policy meetings in October 2016. One non-RBI member, Ravindra Dholakia, had called for a 50 bps cut in repo rate. However, he was outvoted and the MPC choose to keep the repo rate unchanged. There are conflicting views on the expected outcome of the monetary policy as well as on the future inflation trajectory. Whether such opposite views are also seen in the MPC, would be watched out for.

To be sure, the minutes of the policy, to be released after two weeks, will throw more light on the same. For now, one may just have to settle with the voting pattern. Central bank watchers said that a dissent vote would show the evolving nature of MPC without raising questions on credibility.

Stressed loans

One of the key reasons for sluggish credit growth has been the increasing stockpile of stressed loans. By Urjit Patel’s own admissions, “quiescent investment cycle” remains a macroeconomic concern and hence it is imperative to ensure resolution of stressed assets and timely recapitalisation of state-owned banks. While the resolution is underway, the government is yet to infuse the budgeted capital for this fiscal.

Separately, deputy governor Viral Acharya had said that the higher real rates, those adjusted for inflation, can be tolerated because this would act as a disincentive for weak banks to evergreen bad loans. That apart, RBI’s commentary on the resolution of stressed loans, especially those through insolvency code would be keenly watched.

Global factors

One of the key reasons for the rate cut is expected today is because of the supportive global factors. Many economists believe beyond August, it will be difficult for the RBI to cut rates because these factors may not be conducive. The US Federal Reserve is expected to soon start shrinking its balance sheet, while similar unwinding measures, taken to boost growth, are discussed in the euro zone. These factors can have direct impact on the currency market and rupee could see bouts of volatility. Net-net, India has been preferred destination of yield-hungry foreign investors. A rate cut will bring down the interest rate differential, which currently is on the higher side.

Demonetisation

The RBI is yet to reveal how much currency notes have returned after the demonetisation exercise have completed. The 30 June figure for currency in circulation has not been disclosed by the central bank. RBI’s commentary on this along with the supply of currency notes is likely in the policy press conference.

The central bank stopped printing Rs 2000 notes about five months ago and is unlikely to print more in the current financial year but has stepped up the printing of other denominations, including new Rs 200 notes, Mintreported last week.